A CONTRACT is a legally enforceable agreement, or promise, made between two or more ‘parties’. It does not matter whether a Contract is made in writing, or verbally.
Elements of a Contract
While Contracts can take many forms, including Employment Contracts and Lease Agreements, all forms of a Contract require three elements in order to be legally binding on the parties:
- An Agreement; and
- An Intention to create a legal relationship; and
- Consideration.
Additionally, many assessments of Contracts include consideration of another, unofficial ‘Fourth Element’ of a Contract: Capacity & Formality.
The First Element: Agreement
The Second Element: Intention
The second element of a binding contract is INTENTION. Essentially, intention refers to the requirement that the parties intended to be legally bound to the terms of the agreement; and that the nature of the agreement is not merely social.
In determining whether the parties had this intention, our office tends to start by considering the following factors comprehensively (although it’s important to remember that many other factors are often at play; and therefore may influence whether an agreement can be considered a Contract):
Subject Matter
What the agreement is and whether it is of high value.
Context
Whether the agreement was made socially or commercially.
Relationship
The relationship between the parties.
Status
The nature of the relationship, whether the parties are independent and have capacity.
Subsequent Conduct
Specifically, the conduct of the parties after the agreement has been made. This factor basically considers whether the parties, after forming an agreement, proceed to act in a way that suggests they considered that agreement to be legally binding after its formation.
Language
The type of language used to form the contract.
EXAMPLE
If your friend offers to help you do some housework in exchange for lunch and you both agree, there is unlikely to be any intention for it to be legally binding – even though an offer has clearly been made and accepted, and therefore satisfies the definition of an agreement.
The Third Element: Consideration
The final formally recognised element off Contract formation comes in the form of CONSIDERATION. Consideration, an often overlooked yet crucial element of binding Contract, is essentially the word used to describe the ‘something’ given in return for an offer.
Put simply, according to Contract Law, a person who seeks to get something must also give something in exchange.
EXAMPLE
For an Employment Contract, the Consideration is usually the work being completed by the employee; in exchange for payment/renumeration… Whereas in a Lease Agreement, the Consideration is the rent paid to the lessor by the lessee, in exchange for the lessee’s ongoing access to a property or part of a property.
The consideration must be in the form of what has been agreed upon between the parties and, whilst the benefit of the Consideration does not have to be directly received by the Promisor (person who made the offer), it must pass from the Promisee (person who accepted the offer).
In other words, a Promisee must provide Consideration either to the Promisor (or, if other arrangements have been agreed upon in advance, to a third party). Regardless of who receives the benefit of Consideration, it is crucial that the Promisee is the one to provide that Consideration or the Contract is at significant risk of not being legally binding.
It is also important to note that past actions which may have met the definition of Consideration cannot be relied upon in a legally binding Contract. Consideration cannot occur in the past.
While Consideration may be accepted as legitimate for an act that is being performed, or is to be performed in the future, it will not be valid if the Consideration occurred before the ‘act’ which it is providing Consideration towards.
EXAMPLE
An example of past consideration may arise if John buys a car from Lucy, but attempts to claim that partial payment for the car was already made when, months ago, John paid for Lucy’s holiday to Bali.
Additionally, Consideration must be of some value. This is not to say that the Consideration must be highly valuable – rather, outlines that Consideration must be in a form that can have a value of some kind prescribed to it.
Money, tangible assets and/or provision of a service can each have some value prescribed to them – therefore money, tangible assets, and the provision of a service are all valid forms of Consideration. Alternatively, something intangible such as ‘love’ or a promise ‘to stop being annoying’ cannot be afforded any value – therefore, cannot be relied upon as Consideration.
Whilst it is true that Consideration must have some value, it is important to remember that value does not need to be of equal weight to the broader picture of the overall agreement. This, referred to as ‘adequacy’, means that Consideration does not have to equal the value of any promise entailed within a Contract so long as all parties agree. Basically, there is no test of ‘fairness’ – however, there is a test of suitability: meaning that Consideration cannot involve the Promisee agreeing to do something that they previously agreed to do already; or already has some form of pre-existing obligation to do irrespective of the Contract.
When developing an understanding of Consideration, it is important to also recognise that the Promisee’s performance of an existing Contractual duty to a third party may be accepted as valid.
The ‘Other Elements’: Capacity & Formality
Occasionally considered the fourth element to the formation of a binding contract, Capacity assesses whether the parties entering into a Contract have the ability and cognisance to do so.
People who do not have full capacity to enter into a legally binding contract may include minors or those with mental impairments (including those who are intoxicated) – although the list is broad. Remember, Capacity is not universally recognised as a precondition to a Contract being legally binding – unlike the first three elements – and Contracts with minors and/or people experiencing mental impairment may still be formed (however, there are particular rules and requirements to protect these vulnerable parties; and ensure Capacity may still be reached where appropriate).
With regards to Formality, it has already been discussed that binding contracts can be formed verbally. However, there are certain types of Contracts that are will not be recognised as legally binding unless they have been made in writing – and these ‘certain types of Contracts’ vary throughout Australia, depending on where you live. Often, Contracts involving use of property have ‘Formality’ element(s) to satisfy in order to be legally binding – although you should always speak to a legal expert, before concluding whether your Contract is binding or not.
